Accounting Interview Questions for Investment Banking

Bankers open with accounting because it filters out candidates fast. The three-statement walkthrough takes 60 seconds; the depreciation follow-up takes another 90. Either you can do it cleanly or you cannot — there is no middle ground. Cracking under accounting kills the interview before valuation or M&A even comes up.

The deeper test is whether you understand why each adjustment exists. Anyone can memorize 'add back depreciation in cash flow.' The candidates who pass also know that the add-back exists because depreciation is a non-cash GAAP allocation of past capex, that book depreciation differs from tax depreciation and creates deferred tax, and that aggressive depreciation policy can flatter near-term EPS while building a hidden tax liability.

The income statement shows profitability over a period: revenue minus operating expenses minus interest minus tax equals net income. The balance sheet is a snapshot at a point in time: assets equal liabilities plus equity. The cash flow statement bridges the two: it starts from net income, reverses non-cash items (D&A, SBC, deferred tax), adjusts for working capital changes, then layers in investing (capex, M&A) and financing (debt, equity, dividends, buybacks) flows.

• Net income flows to retained earnings. Net income minus dividends increases retained earnings on the balance sheet and is the top line of the operating section of the cash flow statement.
• Ending cash on the CFS equals cash on the balance sheet. If they do not tie, the model is broken. This is the first sanity check on any merger or LBO model.
• Balance sheet changes drive CFS adjustments. Increase in receivables = cash use (the customer hasn't paid yet). Increase in payables = cash source (the company hasn't paid suppliers yet).

The classic interview question. 'If depreciation goes up by $10 with a 35% tax rate, walk me through all three statements.' Income statement: EBIT down $10, taxes down $3.50, net income down $6.50. Cash flow: net income down $6.50, add back $10 of D&A, operating cash flow up $3.50. Balance sheet: PP&E down $10, cash up $3.50, retained earnings down $6.50. Balanced.

Income Statement
  EBIT             -$10.00
  Taxes            -$3.50
  Net Income       -$6.50

Cash Flow Statement
  Net Income       -$6.50
  + D&A            +$10.00
  Δ Operating CF   +$3.50

Balance Sheet
  Assets:   PP&E   -$10.00
            Cash   +$3.50
  Equity:   RE     -$6.50
  Check:    Δ Assets  = -$6.50  =  Δ Equity

Working capital is current assets minus current liabilities. Operating working capital — receivables plus inventory minus payables — measures what operations tie up in the supply chain. Growing companies consume working capital: they need more receivables and inventory before customers pay, and that draw on cash often exceeds reported income.

The cash trap is when reported income is positive but operating cash flow is negative because working capital is exploding. Bankers test this because it is the leading indicator of distress in otherwise profitable businesses.

Deferred tax arises from timing differences between book and tax accounting. The classic source is depreciation: tax authorities typically allow accelerated depreciation, so taxable income is lower than book income early in an asset's life, generating a deferred tax liability. The DTL reverses as the asset matures and book depreciation eventually exceeds tax depreciation.

Deferred tax assets work the opposite way: NOL carryforwards, accrued expenses not yet deductible, stock-based compensation timing. DTAs sit on the balance sheet until the underlying timing difference reverses, at which point they reduce the cash tax payment in that future period.

Inventory is recorded at cost on the balance sheet and moves to COGS when sold. The accounting convention controls which cost moves. FIFO assumes the oldest inventory is sold first; LIFO assumes the newest.

In rising costs, FIFO shows lower COGS and higher net income, while LIFO shows higher COGS, higher tax shield, and lower reported income. LIFO is permitted under U.S. GAAP but not IFRS. Cross-border comparisons require converting LIFO firms to FIFO using the LIFO reserve disclosed in footnotes.

Issuing $100 of debt at 8% with a 35% tax rate. Issuance: cash up $100, long-term debt up $100, no income statement impact. Year 1 interest: interest expense $8, pre-tax income down $8, taxes down $2.80, net income down $5.20. Cash flow: operating cash down $5.20 (interest is paid in cash, no non-cash adjustment). Balance sheet: cash down $5.20, retained earnings down $5.20.

The principal sits on the balance sheet until repayment. The tax-shield benefit of debt — interest is deductible — is what makes WACC lower than cost of equity and is the engine behind LBO returns.

Buying back $100 of stock has no income statement impact at the moment of repurchase. Cash flow: $100 cash out in the financing section. Balance sheet: cash down $100, treasury stock up $100 (treasury stock is a contra-equity account, so an increase reduces total equity). Diluted shares outstanding decrease, mechanically increasing future EPS.

Buybacks are a popular use of capital when management believes shares are undervalued or when there are no high-return reinvestment opportunities. They are also tax-efficient versus dividends in many jurisdictions.